Financial market theory
Financial market theory deals with the following core topics [Patrick Wegmann, 2005]
- Pricing of capital investments
- Evaluation of investment projects of companies
- Questions about the optimal choice of an investment portfolio ( portfolio theory )
- Market efficiency and information processing by market participants, that is, it raises the question of whether the market can be beaten as planned
- The question arises of what the optimal capital structure and dividend policy of a company should look like ( corporate finance )
- Evaluates the possibility of arbitrage , that is, asks the question of whether there is a risk-free profit without capital investment
- Evaluates how much an option to buy or sell an investment is worth ( option price theory )
- Investigates which conflicts between ownership and management ( agency theory ) can exist and how these affect the value of an investment
These questions are approached with econometric and statistical methods, with decision theories on situations under uncertainty and with probability calculations.
What is a financial market?
Financial markets are trading venues where savings and investment needs are coordinated. In this market the suppliers and buyers of financial contracts are brought together. Due to the availability of telecommunications and electronic stock exchanges, the term market no longer refers to a location, but only describes the mechanisms of price formation with which supply and demand are coordinated, as well as the modalities of contract processing ... Financial markets differ from goods markets in their special characteristics Design of the commercial objects. When concluding a financial contract, the investor pays the borrower a sum of money and in return receives certain rights, which in particular concern future capital returns. If the investor acquires a share certificate, i.e. if his investment has the character of equity , he receives not only the right to future dividends but also certain rights of control over the financed company. [Zimmermann, 1993]
Difference to the goods market
The main difference to the goods market lies above all in the future-oriented nature of the acquired legal claims and that only monetary payments, possibly supplemented by further legal claims, are exchanged.
Financial markets by function type
Financial markets can be divided into functions:
-
Capital markets : These serve to raise and invest capital.
- Equity is issued or traded on stock markets as a documented property right in the form of share certificates ( shares or participation certificates ).
- On the bond market are bonds (CH: bonds) emitted or traded.
- Money markets are used for short-term refinancing and investments among commercial banks .
- Risk transfer through the derivatives market
- International trade through foreign exchange market with pricing function for the exchange rate
Subdivision into primary market and secondary market
Further, each of these financial markets can be divided into
The initial issue of financial contracts, that is, the issue takes place on the primary market . The issued financial contracts are usually securitized as securities and, due to their fungibility , can be traded on the secondary market after issue . The trading of financial contracts on the secondary market fulfills an important function for financial market participants. This trading promotes liquidity , which plays an important role in pricing. A liquid market enables the holders of financial contracts to sell them at any time. Secondary trading on an exchange means that the contracts will always find a buyer with the right preferences in terms of duration , amount and risk . This optimizes the macroeconomic capital and risk allocation.
Price-determining factors
Those who invest today postpone their consumption to a future point in time, they temporarily forego their current consumption options. This temporary waiver of the availability of his capital causes costs for the investor (e.g. renouncement of consumption ) for which he wants to be compensated. The capital market compensates for these costs in the form of a risk-free interest rate. In an ideal world with complete transparency and without risk, the investor will lend his capital to the borrower with the highest promised return, which must at least correspond to the risk-free interest rate. In the real world, however, there is, among other things, uncertainty about the future monetary value (inflation), the future interest rate, the future ability of the debtor to repay the loan (creditworthiness) as well as the possibilities of the borrower from the financed projects in the future sufficient payment returns in the form of dividends or interest payments to generate. The current value of an investment is therefore shaped by three determining factors:
- Time horizon
- risk
- information
literature
- Patrick Wegmann: Overview of financial market theory . Lecture notes, University of Basel, Basel 2005.
- Heinz Zimmermann: Financial Markets . Wf-Wirtschaftsförderung, Zurich 1993.